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Term Test 2 Study Guide

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Jack Carr

ECO 100 Term Test 2 Study Notes 13. The Costs of Production Goal of firms is to maximize profit (= total revenue total cost) When analyzing a firms behaviour, important to include all the opportunity costs of production. Some (e.g. wages) are explicit; others (e.g. wages firm owner gives up by working in firm rather than another job) are implicit Firms costs reflect its production process. Production function typically becomes flatter as the quantity of an input increases (diminishing marginal product), firms total-cost curve becomes steeper as quantity produced rises Firms total cost can be divided between fixed & variable costs. From a firms total cost, 2 related measures of cost are derived: ATC is TCQ and MC=TC risif output increases by 1 unit Often useful to graph ATC & MC. Typically, MC rises with Q(output) & ATC first falls as output increases & then rises as output increases further. MC curve always crosses ATC curve at min of ATC Firms costs often depend on time horizon many costs fixed in short run but variable in long run (ATC may rise more in short than long run when Q) Accounting profit TR TC[explicit] Constant returns to scale property whereby long-run ATC stays same as Q(output) changes Diseconomies of scale property whereby long-run ATC rises as Q(output) increases Economic profit TR TC (including both implicit & explicit costs) Economies of scale the property whereby long-run ATC falls as Q(output) increases Efficient scale the quantity of output that minimizes average total cost Explicit costs input costs that require an outlay of money by the firm Implicit costs input costs that do not require an outlay of money by the firm Whenever MC < ATC, ATC is falling. Whenever MC > ATC, ATC is rising. MC curve crosses the ATC curve at its minimum. www.notesolution.com14. Firms in Competitive Markets Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces. Price of good = both firms average revenue & marginal revenue. To maximize profit, firm chooses Q of output such that MR = MC. Because MR for a competitive firm = Pm , firm chooses Q so that P = MC. firms MC curve is its supply curve In short run when firm cannot recover its FC, firm will choose to shut down temporarily if P of good < AVC. In long run when firm can recover both FC & VC, will choose to exit if P < ATC In market with free entry & exit, profits are driven to 0 in long run. In LReq, all firms produce @efficient scale, P = min of ATC, & # of firms adjusts to satisfy Q demanded @ this P Changes in demand have different effects over different time horizons. In short run, increase in D raises P & leads to profits, & decrease in D lowers P & leads to losses. But if firms can freely enter & exit market, in long run # of firms adjusts to drive the market back to 0-profit eq. Competitive market: 1. Many buyers & sellers in the market 2. Goods offered by various sellers are largely the same 3. Perfect knowledge of prices & technology 4. Firms can freely enter or exit the market in the LR For all firms, average revenue = P of good For competitive firms, MR = P of good At the profit-maximizing level of output, MR & MC are exactly = Because firms MC curve determines the Q of good firm is willing to supply @any price, it is the competitive firms supply curve
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